This article was originally published on October 24, 2019. It was updated on August 20, 2020 to reflect additional guidance from the Governmental Accounting Standards Board.
The effective date of GASB 87 Leases is scheduled for fiscal years beginning after June 15, 2021, and all reporting periods thereafter. Whether your state or local governmental organization is a lessor, lessee, or both, the way that you account for leases will change radically, and you have compliance obligations you need to prepare for well in advance. Getting a firm grasp on the definition of a lease and contracts that meet that definition is critical. Once you’ve categorized your leases, you can follow some orderly steps for implementation.
Understand the three categories of leases
GASB 87 defines a lease as a “contract that conveys control of the right to use another entity’s nonfinancial asset (the underlying asset) as specified in the contract period of time in an exchange or exchange-like transaction.” Nonfinancial assets include land, equipment, buildings, and vehicles.
There are three categories of leases.
Short-term leases have a term of 12 months or less, including any options to extend, regardless of their probability of being exercised. Leases that are month-to-month are considered short-term. Short-term leases will be accounted for similarly to operating leases, with lease payments being recorded as expense or revenue to the lessee or lessor.
Contracts that transfer ownership
If the underlying asset transfers ownership to the lessee by the end of the contract, the transaction should be reported as a financed purchase of the underlying asset by the lessee, or sale of the asset by the lessor.
All other leases
Any agreement that doesn’t qualify as a short-term lease or ownership transfer contract will fall into this category, with implications for both lessees and lessors.
- For lessees — At commencement of the lease term, the lessee should recognize a lease liability as an intangible right-to-use lease asset. The lease liability will be measured at the present value of payments expected to be made during the lease term. Lease payments will result in a reduction of the lease liability and recognition of interest expense, as all leases under the standard will be considered finance leases. The lease asset will be measured as the sum of the initial measurement of the lease liability, initial direct costs, and lease payments made at or prior to commencement, less any lease incentives received from the lessor at or before the commencement of the lease term. The lease asset will be amortized over the shorter of the lease terms or the useful life of the underlying asset.
- For lessors — At commencement of the lease term, a lessor should recognize a lease receivable and a deferred inflow of resources. The lease receivable should initially be measured at the present value of lease payments expected to be received during the lease term. Lease receipts (payments from lessee) will result in reduction of the lease receivable and recognition of inflows and revenues. The deferred inflow of resources should be measured as the sum of the initial measurement of the lease liability and lease payments received at or prior to commencement, less any lease incentives received from the lessor at or before the commencement of the lease term. The lessor should not derecognize the asset underlying the lease and continue to record depreciation, as applicable.
Follow a practical process for implementation
When your organization is prepared to fully implement the new standard, this high-level outline can guide you from start to finish.
- Establish project oversight
- Identify the project team
- Identify key issues and project requirements
- Develop a high-level project plan
- Determine the approximate time it will take to complete implementation
- Orientation and training
- Gain an understanding of the current state of your government’s leasing and service contracts
- Create a detailed project plan for each lease type
- Develop a training program customized to your entity’s teams
- Evaluate various lease management tools and software
- Lease inventory
- Develop a process for identifying and reviewing current contracts
- Input of key leasing data/terms into leasing template or software
- Perform a calculation to determine opening balance of lease liabilities and assets
- Functional areas
- Develop on-going processes and controls to maintain the lease inventory
- Implement modifications to existing accounting and reporting processes
- Implement modifications to accounting policies and process documentation
Turn to the final GASB 87 implementation guide for further help. The new questions and answers section may be particularly valuable.
How we can help
It’s our job to understand GASB rules inside and out. Our state and local government professionals can help you review your lease agreements, implement accounting and reporting procedure changes, train your staff, and prepare to fully comply with the new lease accounting standard.